Venture capital is not broken

Gerry Langeler: People point to the disappointing returns for venture capital partnerships over the past decade, and declare solemnly that "the model is broken." This seems to be a popular refrain in blogs. Guess what? If the VC model is broken, so is investing in public equities!

Here's a handy little link where you can go explore how the various popular public stock indices have done over whatever period of time you care to enter. If you happen to enter the date range of June 1, 2000 to June 1, 2010 you see a stark validation of this.

The compounded returns are: Dow Jones Industrial Average off 0.60 percent; S&P 500 down 2.98 percent; and the NASDAQ down 4.66 percent. Compounded over 10 years, and those are very meaningful numbers, especially the NASDAQ (10 years at -4.66 percent means approximately 50 percent reduction in value).

A simple way to think of this is that while the NASDAQ is a high beta (more variable) S&P 500, venture capital is a high beta NASDAQ. So, it's not surprising that the average venture capital fund from the early 2000's is underwater. Swimming against that kind of tide, it would be shocking if it were otherwise.

Now, this is not to say that venture capital doesn't have its challenges, some of them newer than others.

The combination of too much money chasing too few terrific deals led to both too high prices and duplication of company formation, especially during the late 1990s and early 2000's. Regulations such as Sarbanes-Oxley has put a serious dent in IPO attractiveness. The advent of Web 2.0 tools allowed companies to get started for far lower amounts of capital than they needed a decade ago, which has caused venture capitalists to have to adjust their thinking, at least for those kinds of deals.

Entrepreneurs have seen a resurgence of "cottage industry" opportunities, writing apps for iPhones or Droids. While those projects may not grow lasting, highly valued enterprises, they can certainly put some interesting numbers in the bank for a few clever programmers.

However, there is still a need for new enterprises that consume serious amounts of capital to produce serious solutions to serious business, health care and environmental problems.

As wiser folks have noted, the most dangerous words in investing in any asset class are: "This time it's different!" People have already forgotten the declarations that venture capital was dead after the first VC bubble burst in the mid/late-1980's. Those who believed that then missed all the fun and profit of the 1990's. Likewise, those who believed in the late 1990's that "this time it's different" and the good times would last forever got clobbered when the bubble burst.

Whether you are an investor or an entrepreneur, it pays to pay close attention to history, and notice that the world goes in cycles. "History doesn't repeat, but it rhymes."

My guess is that we are now at an inflection point for both entrepreneurs and VCs. Bruised from an awful decade and coming off the worst recession since the 1930's, we are also looking at China and India about to add as many people to the middle class as are in the world middle class today. That is a huge bow wave we can all ride. Sure, there are all sorts of strains on our economic system and on our planet. But that's been true before, too.

To be an entrepreneur or a venture capitalist, you have to be both optimistic and a little bit crazy. But it's not crazy to look at the numbers from public equities and recognize the headwinds we've all been working against for the last decade.

Let's get over it.

The next time someone pontificates to you about the venture capital model being broken, ask them how the stock market has done the last 10 years.

If everything is broken, maybe nothing is. Then, just maybe, we can get past the nattering nabobs of negativitism (the only good thing to come from Vice President Spiro Agnew) and start focusing on the coming boom.

And it is coming.....

Gerry Langeler is a managing director at OVP Venture Partners, a Kirkland venture capital firm. You can read more of Langeler's writings on the OVP blog. Opinions expressed in guest posts are those of their authors, and don't necessarily reflect the views of TechFlash or its staff. Have an idea for a guest post of your own? Email us: techflashtips@bizjournals.com